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You worked hard and built a successful, valuable business. You wonder, “Is it is time to sell?” Now could be the time to travel and enjoy the fruits of your labor and check items off your bucket list. But if you decide to sell, now is also the time to pay a large capital gains tax to the IRS on the gain from the sale of your business. What if you had a choice? What if you could take a portion of the proceeds and give it to charity instead of to the IRS? What if you could make that gift to charity and also retain an annuity for the rest of your life?

You may be able to achieve all of these goals through the use of a Charitable Remainder Trust (“CRT”). Basically, a CRT is a trust that provides a specific distribution to one or more non-charitable beneficiaries for a specified period of time, and once the initial period expires, the remaining balance is held for or distributed to one or more qualified charitable beneficiaries. The specified period of time may be for either: (i) your lifetime (including your spouse’s lifetime) or (ii) for a term of years. When an individual gifts property to a CRT, he or she will receive a charitable income tax deduction in the year of the gift. Moreover, if the CRT later sells the property, the CRT pays no capital gains on the proceeds of the sale. As a result, it is possible for an individual to give an appreciated asset to a CRT in return for a lifetime annuity, benefit from a current charitable income tax deduction and eliminate the capital gains tax on the sale of the appreciated property donated to the CRT.

For illustration purposes, assume the following: Husband and Wife own a business and received an offer to purchase their business for $5,000,000. Their investment in the business is $1,000,000, so a sale for $5,000,000 would generate a $4,000,000 gain. For ease of discussion, assume the entire $4,000,000 gain is long-term capital gain subject to a 20% tax rate with no ordinary income tax component. Therefore, if Husband and Wife sold their business without utilizing a CRT, the tax payable to the IRS would be $800,000 (20% of the $4,000,000 gain). However, if Husband and Wife created a CRT and gifted their corporate stock to it prior to the sale, instead of paying an $800,000 tax on long-term capital gains, they would have a current charitable income tax deduction of at least $500,000 against other income. This $500,000 charitable deduction translates into an out-of-pocket savings of $200,000 in taxes Husband and Wife would have paid on other types of income they recognize. On top of the real savings of $1,000,000 in the year of the gift and sale, Husband and Wife are entitled to an annual payment from the CRT for the rest of their lives. Finally, since the CRT is exempt from paying taxes, the CRT is able to invest the entire amount of the $5,000,000 sale proceeds in income-producing assets. Had Husband and Wife not utilized the CRT, they would only have had $4,200,000 available for investment (the $5,000,000 proceeds net of the $800,000 tax paid). There is now an additional $800,000 available to earn income for both Husband and Wife and the Charity.

Check back next month for Part 2 when I discuss the types of income streams available to Husband and Wife in return for their gift to the CRT.